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Friday, November 10, 2006

Concern Over Japanese Recovery Grows

FT Tokyo correspondent David Pilling is no fool. He may have overly bought the recent 'sustained recovery' story, but he certainly has not surrendered all his critical faculties and he continues to be one of the more 'on the ball' commentarists as far as things Japanese go. Two recent articles make this plain.

In the first place he is aware of the risks associated with a 'pre-emptive raising of rates by the Bank of Japan:

Japan's central bank will move pre-emptively against inflation, Toshihiko Fukui, Bank of Japan governor, said on Tuesday in comments that increase the likelihood of a further rate rise before the end of the year.

His remarks reinforce the bank's insistence that it will not tie its policy to the headline rate of inflation, which has been sliding, partly due to technical factors.

This allows no buffer against slipping back into deflation, and the bank has resisted hitching its policy to a specific inflation target.

Jonathan Allum, Japan strategist at KBC Financial Products, said: "The nightmare scenario is that A: you begin to see evidence of economic contraction, B: you get a return to deflation, and C: the Bank of Japan ignores all this and tightens anyway."

Mr Allum said the economy had been slowing for nearly a year and that it could even contract in the third quarter because of sluggish consumer spending. "Clearly there is a danger that the BoJ is too gung-ho in its view of the economy," he said. "If energy prices are excluded, as they are in most economies, Japan is still in deflation."

The consumer price index, excluding fresh food but including energy, rose 0.2 per cent over the previous year in September, lower than expected. Excluding energy prices, it fell 0.5 per cent. If oil prices remain constant, economists say the headline rate could fall back into negative territory in the first quarter of next year.

Hiroshi Shiraishi, economist at Lehman Brothers, said the BoJ was prepared to ignore the headline number. "The BoJ is not tied to the current reading of CPI," he said. "That's going to give you the wrong answer [in predicting the next rate rise]. They are looking one or two years ahead and they are confident that the Japanese economy has ended the adjustment process and that the output gap has been closed."

Mr Shiraishi said one danger of a premature rate increase was that there could be a rapid reversal in the carry trade, where investors borrow cheaply in yen to buy higher-yielding foreign assets. If money flowed back to Japan it could push up the yen sharply, potentially damaging exports.

Secondly, and today, he draws our attention to the problem of 'recovery derailment' presented by any attempt to tighten fiscal policy (something which at some point is inevitable in Japan, given the scale of the debt):

Japan can continue its controversial policy of cutting public spending without damaging the country’s growth prospects, Koji Omi, finance minister, told the Financial Times in an interview on Thursday.

In a strong defence of government policy, Mr Omi said: “Our thinking is that economic growth and financial consolidation are compatible rather than contradictory.” He believed the economy remained fundamentally strong.

Mr Omi’s comments precede next week’s release of official figures for third-quarter gross domestic product growth. A sharp contraction in private consumption, down 1 per cent quarter on quarter, has some economists worried that output may have shrunk in the three months to September.

Paul Sheard, global chief economist at Lehman Brothers, said he was concerned that Japan’s economic authorities were applying the brakes at the wrong time. “The big picture in Japan is that deflation continues and monetary and fiscal policy are both being tightened,” he said. “I challenge you to find any textbook where that is described as an optimal policy mix.”

So the big picture here is that A sharp contraction in private consumption, down 1 per cent quarter on quarter, has some economists worried and The big picture in Japan is that deflation continues. All this seems to me to be so obvious, but it is evidently not obvious to everyone. Nonetheless not everyone is getting it wrong on Japan bigtime, Claus Vistesen for example, who again today has another timely post explaining the ins and outs of what is actually happening in Japan.

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